U.S. securities regulators are warning that investment advisory firms may not be doing adequate due diligence when recommending hedge funds, private equity funds, and other so-called alternative investments, to clients.
The U.S. Securities and Exchange Commission’s (SEC) Office of Compliance Inspections and Examinations issued a risk alert on the due diligence processes that investment advisors utilize when they put clients into alternative investments such as hedge funds, private equity funds, or funds of private funds.
The alert observes some improved industry practices, but also flags various deficiencies, such as firms that: omit alternative investment due diligence policies and procedures from their annual reviews; provide potentially misleading information in marketing materials about the scope of due diligence conducted; and, have due diligence practices that differ from what’s disclosed to clients.
It also notes that firms are generally seeking more information and data directly from the managers of alternative investments; using third parties to validate information provided by alternative managers; and, performing additional quantitative analysis and risk assessments.
“Money continues to flow into alternative investments. We thought it was important to assess advisors’ due diligence processes and to promote compliance with existing legal requirements, including the duty to ensure that such investments or recommendations are consistent with client objectives,” said OCIE director, Drew Bowden.